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The McClatchy Company (MNI)

Q2 2007 Earnings Call

July 19, 2007 12:00 pm ET

Executives

Elaine Lintecum - Treasurer

Gary B. Pruitt - Chairman of the Board, President, Chief Executive Officer

Frank Whittaker - Vice President - Operations

Patrick J. Talamantes - Chief Financial Officer, Vice President - Finance

G. Lynn Dickerson - Vice President - Operations

Robert J. Weil - Vice President - Operations

Christian A. Hendricks - Vice President - Interactive Media

Analysts

John Janedis - Wachovia

Craig Huber - Lehman Brothers

Karl Choi - Merrill Lynch

Peter Appert - Goldman Sachs

Lisa Monaco - Morgan Stanley

Paul Ginocchio - Deutsche Bank

Nicole Black - Wachovia

Jordan Turnow - Brigade Capital

John Deysher - Pinnacle

Michael Sector - Mentor

Edward Atorino - Benchmark

Thomas Russo - Gardner Russo

Jake Newman - CreditSights

Presentation

Operator

Good afternoon. My name is Cara and I will be your conference operator today. At this time, I would like to welcome everyone to The McClatchy Company second quarter 2007 earnings conference call. (Operator Instructions) Ms. Lintecum, you may begin your conference.

Elaine Lintecum

Thank you for joining us today for our second quarter conference call. This call is being webcast at McClatchy.com and the webcast will be archived for future reference. Joining me this morning is Gary Pruitt, our Chairman and CEO; our Vice Presidents of Operations, Lynn Dickerson, Bob Weil, and Frank Whittaker; our Vice President of Interactive Media, Chris Hendricks; and our Vice President and CFO, Pat Talamantes. We’ll all be available for questions at the end of Gary’s remarks and I’ll also be available after the call. I can be reached at the following number: 916-321-1846.

Our earnings release and statistical report were issued this morning before the market opened. The release includes a summary of unaudited results and the full text of our release and statistical reports are posted on First Call and on our website for your convenience. The company’s results from continuing operations since the close of the Knight Ridder acquisition and all pro forma amounts include the operations of the 20 retained former Knight Ridder newspapers and all of our previously owned newspaper operations except for the Minneapolis Star Tribune, which was sold on March 5th.

A reconciliation of pro forma 2006 revenues to GAAP reported revenues and other non-GAAP amounts are included in the release and can be found on the company’s website at the investor relations page.

As a reminder, this conference call will contain forward-looking statements that are subject to risks and uncertainties, including among others those described in the company’s 2006 annual report on Form 10-K filed with the SEC. Actual results may differ materially from those described during the call.

Now, here’s Gary Pruitt, our CEO.

Gary B. Pruitt

Thanks, Elaine. Good morning. We reported second quarter earnings from continuing operations of $39.2 million, or $0.48 per share, subject to final resolution of the accounting treatment of the Seattle Times first settlement payment discussed in our press release. Earnings from continuing operations in the second quarter of 2006 were $32.2 million, or $0.69 per share.

While the revenue environment is certainly challenging, we’re responding with strong cost control. In the second quarter, we reduced cash operating expenses by 12.2% on a pro forma basis. In fact, our operating cash flow grew 4.4% on a pro forma basis, despite the decline in revenue and our second quarter operating cash flow margin was 26.9%.

Our revenues from continuing operations in the second quarter of 2007 were $580 million, compared to pro forma revenues from continuing operations of $632.4 million in 2006. That is including all the newspapers as if they had been owned since the beginning of 2006.

Advertising revenues were down 9.8% from pro forma advertising in 2006 and circulation revenues were down 4.6% on a pro forma basis. As we noted last month at the mid-year media conference, our advertising revenues have been hurt by the downturn of the real estate market, particularly in California and Florida. Together, these two regions represent 35% of our advertising revenues but account for 72% of our ad revenue decline.

Real estate is a significant factor in the economies of these two states and the downturn has had a spillover effect into other sectors, so in those regions we are seeing large declines in auto and employment advertising as well.

Let me assure you that we feel good about the future of our California and Florida regions. These are resilient markets with high growth and they were our best performers in the recent past and we expect them to be there again.

Let’s look at revenues by category, starting with retail. Retail advertising was down 6.2% on a pro forma basis with declines in our print products partially offset by strong growth in online retail advertising, which was up 59.8% in the quarter driven by banner advertising.

Classified advertising was down in each major category. Overall, classified advertising revenues declined 14.9% compared to growth of 4.5% in the 2006 quarter on a pro forma basis. Here is a review by category; employment -- in the second quarter, employment advertising declined 15.5% of our newspapers compared to growth of 7.3% from pro forma 2006 second quarter revenues. The declines were recorded in both print and online.

In particular, employment was affected by the current affiliate agreement with CareerBuilder for online employment advertising. This agreement is helping to grow online employment revenues at the legacy McClatchy papers, up 15.7% in this category, and is an attractive agreement for these papers. However, under the current affiliate agreement, selected products are no longer available to be sold by the 20 acquired Knight Ridder papers, which has depressed their Internet revenues.

As we’ve previously mentioned, we’re in discussions with Gannett and Tribune to change the affiliate agreement to be more equitable for our papers and are hopeful that a resolution will be reached shortly. It’s our clear preference to remain with CareerBuilder but we have not made a final decision about our online employment solution yet. In any case, we will begin to cycle over the current affiliate agreement in August of this year.

Next, automotive; automotive advertising declined 15.4% compared to a 9.6% decline in the second quarter of 2006 pro forma advertising, as our domestic car dealers continue to struggle and consolidate. Still, our online automotive adverting was up 12.9% in the quarter, reflecting the success of our cars.com products.

Finally, real estate; real estate advertising was down 19.0% compared to a 17.2% increase in the 2006 quarter. Of the total $12.8 million second quarter decline, $11.1 million was in California and Florida, where real estate advertising was exceptionally strong in 2006. We expect declines in this revenue category to continue because of the difficult comparisons in those states.

Turning to national advertising, it declined 9.4% on a pro forma basis in the second quarter. Our performance continued to be hurt by losses in telecommunications, national automotive and financial advertising, trends we are seeing industry-wide.

While online advertising was included in the results discussed above, we wanted to give you a sense of how our online advertising is performing. On a pro forma basis, online advertising decreased 2.2% compared to the second quarter of 2006. As we have previously mentioned, our growth rate has been stunted in the employment category due to the revised CareerBuilder affiliate agreements.

We continue to feel good about growth in most other online advertising categories. Excluding online employment advertising, our online advertising revenue grew 13.0% in the quarter, reflecting the underlying strength of this business. Online advertising represented 8.8% of our total advertising revenues in the second quarter and through the first six months of the year.

We continue to roll out new and innovative products and content on our websites, which are well-received by users as reflected by our growing audiences. Our average monthly unique visitors grew 22% and page views were up 23.4% in the second quarter.

Our direct marketing advertising revenues declined 3.9% in the quarter, reflecting the overall slow advertising environment. As you know, we extend our newspaper franchises by supplementing the mass reach of the newspaper with direct marketing and direct mail products so that advertisers can both achieve broad appeal and capture targeted audiences with one-stop shopping.

We believe we will have growth in direct marketing advertising as the overall advertising environment improves, and through this June these revenues represent 8.0% of total advertising revenues.

Turning next to circulation, on a pro forma basis, our daily circulation declined 3.7% and Sunday was down 4.4% in the quarter as we continue to cull out third-party and outlying circulation that is not valued by our advertisers.

Our strategy is aimed at growing and retaining quality circulation at our newspapers while rapidly expanding the audiences served online. This integrated approach results in growth in our total audience throughout our markets and means we deliver a greater reach to serve our advertisers.

Turning next to expenses, total cash expenses were down $59 million, or 12.2% on a pro forma basis, as we continue to reign in costs during this tough revenue environment and as we realize synergies from the acquisition. Synergies accounted for a little less than half of our expense decline.

Looking at it by category, compensation costs on a pro forma basis were down 12.5%; salaries declined 12.4% and FTEs were down 6.9%. Various accruals made by Knight Ridder in the June 2006 period have also affected the pro forma comparisons. So while compensation will continue to trend down, this rate is not the run-rate that you could expect going forward.

Newsprint and supplement costs were down 17.0% on a pro forma basis, reflecting both lower newsprint prices and usage; and finally all other expenses decreased 8.6% on a pro forma basis.

Depreciation and amortization expense increased $28.4 million, due primarily to the additional assets and purchase price accounting related to the acquisition. Net interest costs from continuing operations were $49.6 million. The company’s net debt balance at the end of the quarter was $2.68 billion, down $79 million from the end of the first quarter. Our effective interest rate in the second quarter was about 6.4%.

Currently, we’re in the midst of several deleveraging transactions related to the sale of certain assets and property. With these transactions and free cash flow generated by operations, we expect to reduce debt by approximately $600 million to $700 million over the next 18 months.

As we look to the third quarter, we expect continued declines in real estate advertising, particularly in California and the Florida newspapers. We expect no substantial improvement in advertising trends before the fourth quarter of 2007 and expect that revenues will likely still be negative in that quarter.

In the meantime, we’re working hard to offset the impact of revenue declines by exerting strong cost discipline. Also, we expect to record losses from our equity investments that reflect the impact of lower newsprint prices and higher raw material prices on the results of both SP Newsprint Company and Ponderay Newsprint Company. We expect our total equity losses to equate to $0.07 per share in the third quarter largely from these equity investments. As a result of the recently announced strategic alternative review at SP Newsprint, we are seeking to monetize this asset for our shareholders and end the equity losses from that investment.

With our portfolio of newspapers and digital assets in growth markets, new alliances with technology companies, and changes we are making in our cost structure, we approach the future with confidence. We also and always have treated the success of our business and the faith of our investors who support it as a solemn obligation.

Now I’ll be happy to answer any questions you may have about our second quarter results. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of John Janedis with Wachovia.

John Janedis - Wachovia

Thank you. Gary, you touched on this a bit but can you give us a sense of the percentage of revenues in Florida and California that are related to the real estate weakness? In terms of your recovery there, is there some sort of lag that we should be mindful of in terms of that?

Gary B. Pruitt

You are certainly right that the real estate has a ripple effect beyond just real estate itself. I suppose -- should I turn it over -- I’ll turn it over to Frank Whittaker who’s responsible for the Florida papers. Poor guy.

Frank Whittaker

John, we could probably get you more exact information later on but as Gary mentioned in his remarks, there are other categories that are directly related to the real estate slump, notably in retail, home improvement and furniture categories.

We don’t have good data on Florida because as we’ve included them in our financial systems it will take a full year before we have that kind of a year-over-year comparison. I can tell you that in California, the categories, furniture is down almost 17% or $800,000 and the category of home improvement is down almost 16%, or $600,000. So you can see that that is that spillover effect that Gary was referring to.

Gary B. Pruitt

We have an echo on this line. I hope it’s not reverberating for everyone but if you look at the second quarter for total advertising revenues in California and Florida together, they were down 17.8%. All other regions advertising was down 5.0%, so you can see the vastly disproportionate effect. Real estate in California and Florida was down 33.2%, real estate in all other regions combined was down 4.9%.

So California and Florida are certainly taking a toll but as I mentioned in my remarks, they were our best performing states. California was McClatchy's best-performing state for many years and Miami and Florida was for Knight Ridder for many years, so we think the underlying growth of the market will bode well for the long-term but they are having a disproportionate impact right now.

John Janedis - Wachovia

As a follow-up, on a going forward basis though, so for example if real estate starts to improve in 3Q, Frank or Gary, would the other ones, meaning furniture, et cetera, start to improve then or would it be like a 1Q08 sort of thing, or is it just not comparable in terms of how to view that?

Gary B. Pruitt

Well, they are certainly congruent and there may be a little lag but it would not be a long lag.

Frank Whittaker

It would not be a long lag but there is something. I mean, if people start buying then there is some time to get through the home purchase and then start thinking about improvements in furniture.

John Janedis - Wachovia

Just one quick one; Gary, can you clarify your comments on direct mail? Did you say you expect growth at some point this year or just at some point going forward?

Gary B. Pruitt

At some point in this epoch. No, we didn’t say this year. What we are saying is we do expect that it will increase when the general advertising environment increases, so we didn’t have a specific time on it. Right now what we are getting hit, this category from McClatchy includes all print revenue that isn’t in the newspapers. So it includes all of our niche products but importantly includes our direct mail TMC products. So while are niche products are showing growth, it’s those TMC products, the direct mail TMC products that are showing the declines, just as is more reflected in the newspapers. In particularly, Walgreen’s and Lowe’s eliminated their mid-week non-subscriber advertising products throughout the country, so that’s effecting this category. They kept it in the paid product but removed it from the non-subscriber mail product mid-week.

John Janedis - Wachovia

Thank you very much.

Operator

Your next question comes from the line of Craig Huber with Lehman Brothers.

Craig Huber - Lehman Brothers

Good morning. Thank you. Gary, could you just be a little more specific -- real estate, how much is it down in each of California and Florida for the first question?

Gary B. Pruitt

Do you want percentages or --

Craig Huber - Lehman Brothers

Yes, percentages are fine.

Gary B. Pruitt

Okay. Frank.

Frank Whittaker

In California, real estate revenues declined $5.8 million, which was 28.9% of the total decline; and the comparable number in Florida was a dollar decline of $5.3 million, which was a 39.7% of the total decline.

Craig Huber - Lehman Brothers

Okay, and --

Gary B. Pruitt

No, not of the total --

Frank Whittaker

Sorry, of the total decline, 27.3%. Sorry.

Craig Huber - Lehman Brothers

Sorry, so Florida was down 39.7% real estate, if I heard you right, and California down 28.9%?

Gary B. Pruitt

Yes.

Craig Huber - Lehman Brothers

Also, if you could jump over to retail store advertising, retail store down 6.2% for the quarter overall. Can you give us a little more flavor -- why is it down so much in your opinion in your markets? How much of it is layered on top of Florida and California as opposed to the other regions?

Gary B. Pruitt

We’re a little handicapped on the retail side right now because Knight Ridder didn’t have the same breakout and detail on the retail categories that we do but we know that we are seeing an effect in the home improvement areas, the spillover from real estate decline and we are still seeing a pullback in department stores, with Dillard’s pulling back double-digit and Macy’s pulling back. We are hopeful that Macy’s will increase its spending in print but we haven’t seen the effect of that currently.

So in California and Florida, their retail decline is a little steeper than the other regions, between 7% and 8% decline, whereas the rest of the regions are between 5% and 6%. So it is the more broadly based decline. I think not just furnishings and home improvement, although we are seeing that impact with real estate decline but department stores are pulling back as well.

Craig Huber - Lehman Brothers

Also one more; it’s my understanding that in the newspaper you guys have sold here recently, Minneapolis, that the EBITDA, the Minneapolis Star Tribune is down roughly 40% to 50% year-to-date. My question, Gary, because you know this market and newspaper very well, is there anything unique in your opinion in the Minneapolis markets -- EBITDA to go down that substantially, 40% to 50%, is there anything unique in that market where you couldn’t see those sort of fall-offs in EBITDA at some other papers out there, your Miami paper down upwards about 18%, 20% ad revenues, or even some of these other newspapers out there that might potentially be very over-levered here, like a Tribune paper, north of 10 turns of leverage where you could -- is there something unique here where you couldn’t not see that sort of decline elsewhere?

Gary B. Pruitt

I’m hesitant to talk about the Star Tribune. I’m out of date there and kind of happy to be spectator as opposed to an expert in terms of what’s going on there, so I really don’t want to speak to that market. I don’t have current information, nor do I know the current circumstances.

Craig Huber - Lehman Brothers

What about then along those lines of as you think of other large metro newspapers in this country where you have a very high fixed cost base business, newspapers -- is there any other reason why you couldn’t see those sorts of declines or perhaps worse in other markets around the country, perhaps in some of your own papers?

Gary B. Pruitt

I think that larger metros have been hit harder in this era than smaller papers, in part because they had a larger classified base and the Internet competition was keener in the classified area, so that was one piece of it. And then the second piece, you are right, is that metro papers typically have a higher cost structure for various reasons and so that has an impact. Some of that can be a union effect but not all of it.

And then finally, the Internet competition focused more on cities than it did on smaller markets and so they faced more Internet competition as well.

All of those factors are not unique to Minneapolis. They apply to other metros and some other metros are struggling. But I do believe, and I haven’t looked at all of the statistics for all metro papers but classified was a disproportionately large percentage of total advertising in Minneapolis so they may have been more vulnerable than some of the other papers. I say that just not based on looking specifically at the metro paper average but I believe that that is the case, so they may have been a little more vulnerable.

Craig Huber - Lehman Brothers

Thank you, Gary.

Operator

Your next question comes from the line of Karl Choi with Merrill Lynch.

Karl Choi - Merrill Lynch

A couple of questions on the compensation expense. I wonder if there’s a way to quantify the percentage decline in compensation expense on a pro forma basis in the second quarter, excluding the Knight Ridder accrual that you mentioned in June a year ago. And related to that, what’s your expectation for SC decline in the third quarter on a year-over-year basis?

Gary B. Pruitt

We mentioned that roughly half, a little less than half of our expense decline came from synergies in the second quarter but a majority of our compensation decline came from those synergies, whereas a minority of the expenses of course in newsprint and the all other category came from synergies.

So with compensation down, what was it, 12.2? A majority of that was coming from the synergies, but we are building momentum in terms of the compensation category and compensation decline. FTEs were down 6.9% in the second quarter and the vast majority of those were from operations, not from synergies, so with three quarters or so of those coming from the operations so we would expect FTEs to be down in the mid single-digits in the third quarter and -- is that responsive, Karl, to what you --

Karl Choi - Merrill Lynch

That’s helpful. Also, one question on the interest expense line. I know in the first quarter there was some unusual or some items related to tax reserve. Was there anything like that in the second quarter? It looks like the interest expense number was quite a bit higher than what I thought would be the case, given the blended interest rate.

Gary B. Pruitt

Pat.

Patrick J. Talamantes

We’ve still got interest expense on our tax reserves rolling through that line in the second quarter and we’ll have that going forward until we can work that tax reserve down. We’ve got $1.7 million in the interest expense line.

Karl Choi - Merrill Lynch

Was that the only thing unusual, or anything else?

Patrick J. Talamantes

Yes, that was the only thing that was unusual.

Karl Choi - Merrill Lynch

Thank you.

Operator

Your next question comes from the line of Peter Appert with Goldman Sachs.

Peter Appert - Goldman Sachs

Hi, Gary. I was hoping you or Pat could maybe help us better understand, sort of following on to what Karl was getting to, I think, the percentage growth rates and costs in the second-half. As you cycle through the Knight Ridder acquisition, presumably some of the synergy benefits are baked in so is it possible to give us a number in terms of what we might be thinking about broadly in terms of percentage decline and costs in the second-half might look like?

Gary B. Pruitt

Sorry, Peter, can’t help you.

Peter Appert - Goldman Sachs

How about Pat?

Gary B. Pruitt

No, not him either. No, as we said, about half, a little less than half of the expenses came from synergies so a little over half came from operating expenses. We would expect that total cash expenses then would be running in at least down those mid-single-digits in the third quarter, if not a little better than that.

Peter Appert - Goldman Sachs

So I guess the real question was were the cost-savings from the synergies associated with Knight Ridder all implemented in the first 12-month period, or is there any residual coming in the next 12 months? I guess your answer is --

Gary B. Pruitt

No, there’s some coming. There’s some coming on the digital side, as we ramp down from the Knight Ridder digital and consolidate into McClatchy Interactive. Pension expense is a little unfavorable in the second-half, which hurts us a little bit there. We continue to increase through attrition the FTE reduction. That will build over time and so I think you can expect while compensation might not be down in the mid-single-digit range, the overall expenses will be down in that mid-single-digit range with newsprint down double-digit and that’s kind of a run-rate for the third quarter, I think you could expect.

Peter Appert - Goldman Sachs

And then just a question for Chris; is it possible to help us better understand the decline in the online revenue? I understand it relates to the classified categories and I haven’t been able to power through all these numbers just yet but the weakness in online suggests that the weakness in your broad revenue is not just a share shift phenomenon, right? It’s more generally declines in the ad marketplace. The specific question would be any help you can give us in terms of what’s driving the weaker results in the online categories for you guys in terms of categories, geographies, specific advertisers, et cetera.

Christian A. Hendricks

Well, to start with, the real estate category, we are seeing a slight decline in there. That’s associated with the declines in California and also the declines in Florida, so that is hit because the less customers that come to the print side of the business, the less customers we have to upsell products to.

The biggest hit has been in the employment category, as Gary has detailed. If you look at the detail of the papers, you can see the Knight Ridder sites year-to-date are down about 16% in employment revenue while the McClatchy papers are up about 20.5%, so there’s a huge shift there and that shift is in the millions of dollars. And that is the biggest factor that is impacting us slightly the real estate sector, automotive is up year over year, so that’s still a category we’re doing well in and then retail, retail was up -- 70.9% year-to-date, so that’s a big category for us as smaller retailers are coming to the marketplace and buying banner and sponsorship and display ads.

So it is isolated, the declines, really to the employment category and slightly in the real estate category. As soon as we start plateauing over it and also when we get a better affiliate arrangement, we should see some improvement. As Gary said earlier, when you back out that impact of employment, you’ll see that our numbers are up 13%, 14% on the online side.

Peter Appert - Goldman Sachs

Which would then imply, Chris, right, that we should see up numbers then in the third quarter I would think, since we’ll be cycling through the Knight Ridder effect?

Christian A. Hendricks

We start cycling through that Knight Ridder effect in August and it ramps up through the end of the year, so I’d say most likely the real growth we’ll be seeing it in the fourth quarter.

Gary B. Pruitt

Yes, we just begin to cycle on it in August.

Peter Appert - Goldman Sachs

And the last thing, any update in terms of your discussions with CareerBuilder?

Gary B. Pruitt

No update. We’re still continuing to have discussions. I really have nothing to add to what I said in my conference call notes. Our preference is to stay with CareerBuilder. Haven’t made a decision yet. Still in talks with Gannett and Tribune.

Peter Appert - Goldman Sachs

Any timeframe on that, Gary?

Gary B. Pruitt

I would hope it would be -- we would like to resolve it sooner rather than later, so to me that translates to weeks not months.

Peter Appert - Goldman Sachs

Got it. Thank you.

Operator

Your next question comes from the line of Lisa Monaco with Morgan Stanley.

Lisa Monaco - Morgan Stanley

Good afternoon. Just two questions; one, Gary, can you just give us some color on what your expectations are for circulation volume in the second-half and circulation revenue? And then secondly, what’s your thoughts on the announced newsprint price increase? Thanks.

Gary B. Pruitt

With regard to circulation, we expect to see slightly improving trends in the second-half as we roll over some of the culling out of third-party and distance circulation, so the numbers while still down will be improving in the second-half.

Lisa, your other question was the pricing on circulation, is that right?

Lisa Monaco - Morgan Stanley

Circulation revenue, I assume you --

Gary B. Pruitt

Should reflect that same similar trend -- that is, still down but improving with the volume numbers so both slightly improving though both down.

Lisa Monaco - Morgan Stanley

What are you thinking about newsstand and home delivery price increases?

Gary B. Pruitt

We’re thinking that we will have probably no newsstand increases and while we’re not in budgeting, some papers may have modest home delivery price increases but we haven’t sorted that out with the papers yet.

Lisa Monaco - Morgan Stanley

And then, what’s your view on whether the announced newsprint price increase will stick?

Gary B. Pruitt

Chuckle. You know, it’s just -- I think demand is still down and it will be hard for that newsprint price to stick. I understand that it’s a tough business for the newsprint industry. I understand all too well, as you can look at our equity line but the market does not have a heart or a conscience. It’s a worldwide commodity supply and demand market and it would be hard for me to imagine that that price would stick.

There’s nothing I’d say that determines that outcome, of course but it’s hard to imagine a price increase sticking in this advertising environment.

Lisa Monaco - Morgan Stanley

Great, thank you.

Operator

Your next question comes from the line of Paul Ginocchio with Deutsche Bank.

Paul Ginocchio - Deutsche Bank

Thanks. Two questions; any way to size the Google ad sales program now that it’s been expanded? Any way to pull some anecdotes out of what you are already involved with, just to see what it potentially could add, maybe on a percentage basis of your current business?

Second, I think you mentioned at the mid-year media review talking about maybe becoming less vertically integrated in the future. Could you just elaborate on that? Thank you.

Gary B. Pruitt

Google is not a huge impact yet. The results have been encouraging because it has brought in non-traditional new advertisers and to give you a range, Paul, it’s in the several hundred thousand dollar range in our experiment at this point. So it’s been very promising with new advertisers on a small beta program that we are encouraged by.

And then, as far as newspapers becoming less vertically integrated, I think longer term what you will see is that newspapers, typically newspapers have been a quite vertically integrated industry. We had to operate all functions at a newspaper location and there was little that could be centralized or handled by others. It was all -- that was geographically bound.

Technology has changed that and allowed us to centralize or have services done by others and as a result, not everything needs to be done at each geographic location anymore, with centralization of computer systems and possible outsourcing as well.

I think as a result you are going to see newspapers long-term focused much more on their core -- that is, collecting, reporting local news and information and local sales and marketing efforts. That’s a long-term outlook, which I think over many years and decades will result in a less vertically integrated business.

Paul Ginocchio - Deutsche Bank

Okay, great.

Operator

Your next question comes from the line of Nicole Black with Wachovia.

Nicole Black - Wachovia

I was just wondering if you could tell us what CapEx was for the quarter and if you were still expecting about $70 million for the year.

Gary B. Pruitt

Sure. Pat.

Patrick J. Talamantes

As far as the year goes, we are probably going to be a tad under that. For the quarter, we were at $13.9 million. Year-to-date we were at 28.2. We will catch up a little bit in the second-half but it will be more in the high 60s tops this year.

Nicole Black - Wachovia

Is that because you - have you pulled back on any projects?

Patrick J. Talamantes

You’re always looking for opportunities to economize and to balance free cash flow, so yes, it wasn’t due to any other factor.

Nicole Black - Wachovia

Thank you.

Operator

Your next question comes from the line of Jordan [Turnow] with Brigade Capital.

Jordan Turnow - Brigade Capital

Could you talk about the asset sales or divestitures? More specifically, the SP in terms of what you think it’s worth, what you are looking to get? I mean, just ballpark how much debt is on the company there?

Gary B. Pruitt

We nor none of the partners I believe give the debt amount for SP Newsprint. We’re relatively new to this game. We became a one-third owner by acquiring Knight Ridder and the partners have decided to look at strategic alternatives which may result in the sale of the company. It’s on our books for $41 million pretax and we certainly would expect that we would do better than that in terms of proceeds.

But we really don’t have any more detail to add than that.

Jordan Turnow - Brigade Capital

Is it a substantial part of that 600 to 700 you are trying to get?

Gary B. Pruitt

It’s not included in that $600 million to $700 million.

Jordan Turnow - Brigade Capital

It’s not. Okay.

Gary B. Pruitt

It is not. It is not part of that.

Jordan Turnow - Brigade Capital

What is the stuff in that 600 to 700?

Gary B. Pruitt

The stuff in there is free cash flow, you know, just the cash generation from the business, the expected $201 million tax refund resulting from the sale of the Star Tribune, which we would anticipate in the second quarter of 2008, the proceeds from the Miami land sale, which is a contracted amount of $190 million before tax, and the sale of the Knight Ridder jet for $19.5 million, the sale of land in San Jose for $25 million, and other isolated small sales as well. So combined, that’s the $600 million to $700 million.

Jordan Turnow - Brigade Capital

Thank you.

Operator

Your next question comes from the line of John Deysher with Pinnacle.

John Deysher - Pinnacle

Following up on the prior question, the Miami land that’s under contract for $190 million, when do you expect that to close?

Gary B. Pruitt

We expect it to close in 2008 and I would say most likely it would be in the second-half of 2008. But we do expect it to close at that time.

John Deysher - Pinnacle

And that’s an all cash transaction?

Gary B. Pruitt

Yes.

John Deysher - Pinnacle

And the other, the smaller ones, the jet and the San Jose land, what would your guess be in terms of those closing?

Gary B. Pruitt

The jet already closed. It closed in the second quarter and the San Jose land for $25 million is scheduled to close in August of this year, next month.

John Deysher - Pinnacle

Of ’07, okay, fine. And then on the S&P transaction, the $0.07 per share is just related to the S&P or are there write-downs occurring in the other assets as well?

Gary B. Pruitt

Well, the $0.07 is largely related to our newsprint ownership. Most of that is SP newsprint. A portion of that is the Ponderay Newsprint. So those two assets with the majority of the loss coming from SP are accounting for those $0.07. The other equity investments on balance are kind of neutral, I think.

G. Lynn Dickerson

And it isn’t a write-down. It’s just a result of their operations. It’s our portion of their expected operating results.

Patrick J. Talamantes

These are non-cash items that are showing up on the equity loss line.

John Deysher - Pinnacle

Right, okay. No thoughts about monetizing Ponderay at this point?

Gary B. Pruitt

Constantly. I dream about it. But we don’t have -- uh-oh, there’s a board meeting in Ponderay later today. But we haven’t made a secret of it so that’s all right. It’s a little more difficult, given where we were with the partnership and with Bowater. I would hope that when the Bowater Abitibi deal concludes, no matter how that concludes, we might be able to work out an exit strategy there but we don’t have one right now. But long-term, we would like to get out of that long-term or short-term but I think it’s not going to be in the short-term.

John Deysher - Pinnacle

Okay, so Bowater is your primary partner on that one?

Gary B. Pruitt

They are, along with some other newspapers publishers.

John Deysher - Pinnacle

I guess finally I think after the last quarter, you broke down the composition of the equity income or losses in unconsolidated subs. It was $3.4 million this quarter, a big improvement from last quarter. Could you give us the rough breakdown as to what is included in the $3.4 million loss?

Patrick J. Talamantes

I think the biggest turnaround from where we were in the first quarter was in the Internet investments. They posted income of $1.9 million.

John Deysher - Pinnacle

I’m sorry, what was that amount?

Patrick J. Talamantes

$1.9 million of income. Newsprint was a $3.2 million loss, slightly worse than the first quarter. Other investments, which includes the Seattle Times Company and others, at this stage, again subject to the we put in the press release, are flat. And then we have amortization, non-cash amortization resulting from our purchase price adjustments that we had to push through to the equity investments of $2.1 million. Again, amortization of $2.1 million, and that totals to your 3.4.

John Deysher - Pinnacle

And then Gary, I was rereading your annual report this morning and I think in the first paragraph, you talk about $70 million of synergy savings. How much of that have we captured so far, would you guess?

Gary B. Pruitt

All of it.

John Deysher - Pinnacle

Okay, so you’ve got all of it?

Gary B. Pruitt

And at this point I would say it becomes very fuzzy as to what’s synergy and what’s just outright cost control from operations in a challenging environment. So we could expect that there will be a little more synergy saving coming on the digital side as we have consolidated Knight Ridder digital and McClatchy Interactive, so there may be some small amount still to come but we’ve delivered on the $70 million at this point.

John Deysher - Pinnacle

Okay, so the cost reductions going forward are basic restructuring costs.

Gary B. Pruitt

Yes.

John Deysher - Pinnacle

And have you quantified those yet?

Gary B. Pruitt

No, beyond just what we had said on the third quarter that we feel comfortable that they are at least in the mid-single-digit decline area.

John Deysher - Pinnacle

Very good. Thank you.

Operator

Your next question comes from the line of Michael [Sector] with Mentor.

Michael Sector - Mentor

Good morning or good afternoon. Two quick questions; can you just revisit the online CareerBuilder issues? I just missed that part. And if you could, of the $60 million of, or $59 million of reduction in expenses, I guess half came from the merger. Can you break down how much of the other $30 million is from print prices going down and what other things, what other saves you have in there?

Gary B. Pruitt

Sure. In general terms, as far as CareerBuilder goes, you didn’t miss much. There hasn’t been an update since last month; that is, we are still in talks with Gannett and Tribune. We have not made a final decision as to what we will do there but we hope to make the decision soon and our preference would be to stay with CareerBuilder if we could and not disrupt the relationship that our papers have with CareerBuilder, but it still remains to be seen at this point. We’ll let investors know when a decision is reached, we hope within weeks but we can’t be sure. That’s CareerBuilder.

Of the $59 million, yes, a little less than half were synergies and then of the other piece, am I right in saying that a little less than half of that half came from non-newsprint?

Patrick J. Talamantes

Well, some of it is non-newsprint but I think the question was getting towards how much did we pick up from price.

Gary B. Pruitt

Could you clarify your second question? I guess I misunderstood it. I’m sorry.

Michael Sector - Mentor

I guess what I’m trying to understand is let’s say you know $59 million, 29 is from the merger, $30 million is from other things -- how much is just newsprint price and usage going down and how much is other cost saves. I guess the follow-up to that would be how much of that continues into the next half of the year? How much more cost saves can you do? What is this from?

Gary B. Pruitt

Okay, so of that, roughly around 30 or just over 30 -- the 12.9 of that is newsprint. Newsprint savings is going to continue into the next quarter, as will the other savings. In fact, we would expect that there would be a growing sense of momentum on expense control.

Patrick J. Talamantes

As well, Michael, on the newsprint price side, we will see greater newsprint prices in the third quarter. Prices have declined in the second quarter and that rolls through our accounting on the inventory.

Gary B. Pruitt

So it’s greater newsprint savings.

Patrick J. Talamantes

Correct.

Michael Sector - Mentor

If we take $30 million and 15 of that, let’s say $15 million, $16 million is other cost saves, do you see $15 million, $16 million, $20 million of other cost saves in the back-half of the year?

Gary B. Pruitt

Certainly our goal is to increase cost savings but there are some anomalies there that -- you know, pension expense is higher so the benefit costs may be a little higher, so it’s harder to have compensation go down in terms of momentum. But I think you will see overall the expenses at least mid-single-digits down and we hope and expect building some momentum from there.

Michael Sector - Mentor

Appreciate it.

Operator

Your next question comes from the line of Edward Atorino with Benchmark.

Edward Atorino - Benchmark

Two questions; one, there was a news item that the ABC is going to redesign the way it calculates your audience and look at newspaper print and online readership data starting November 5. Is this something that is significant? Will you be able to capitalize on that? Number one, and number two, have you looked at the real estate related advertising? How much of the decline sort of disappeared? I’m thinking sort of the tech boom and the tech bubble, a lot of those people went out of business and never really came back. Do you have a sense of how much of the loss is permanent?

Gary B. Pruitt

Sure. Thank you for the questions. First, with regard to the audience measure, Frank Whittaker is on the ABC Board and knows this in great detail.

Frank Whittaker

Excruciating detail.

Gary B. Pruitt

Yes, but we do regard it as a significant development to measure audience rather than circulation because it allows us to be more directly comparable with other media -- that is, other media sell based upon their audience, their total audience. Circulation is not audience. It’s not even readership because each paper is read between 2.5 and 3 times, so beyond readership and using online audience as well, so we’ll have a better ability to sell and we think that long-term, this will be quite beneficial to our industry. The advertisers want it and we are all better.

Edward Atorino - Benchmark

Would this be in time to effect your ’08 pricing strategy?

Gary B. Pruitt

Not significantly, I don’t believe. I think it’s more of a long-term benefit to us to have audience measures and net sales.

As far as the real estate goes, with real estate, as cycles run through in real estate, people do leave real estate and then come back when the cycle turns back again. We have in many of our markets, especially in California, new homes was a big piece of our advertising revenue. New home building has dried up and so for the current time, they are gone. But they will be back. California has big population growth and we’ve got land in the valley where our papers are as opposed, for the most part, as opposed to the coast where land is in shorter supply. So they will be back but for the time being, that business has dried up.

Edward Atorino - Benchmark

Thank you.

Operator

Your next question comes from the line of Thomas Russo with Gardner Russo.

Thomas Russo - Gardner Russo

Hi, Gary. A couple of questions for you and for Chris. For Chris, can you talk a bit further about the increase in the retail display online, what the pattern is and what it looks like going forward?

Christian A. Hendricks

Certainly. We have aggressively pursued this category the smaller merchants have started to realize the value of display advertising online. New components in there. The volume is definitely increasing and with that volume in certain categories that are high demand, we’ve been able to aggressively push up pricing to effect the CPMs that we charge. We’ve also been able to implement more direct marketing through e-mail for smaller advertisers at higher CPMs.

So as we push forward with the smaller retailers, we expect significant growth in this category. It is now the second-largest category of all the online categories for us behind employment and that happened this year. We did experience substantial growth in the category last year and we are seeing the same this year, so we are very bullish about this category and expect more from it.

Thomas Russo - Gardner Russo

Chris, does it come with any cannibalization off of print?

Christian A. Hendricks

I’m sorry?

Thomas Russo - Gardner Russo

Does it have any cannibalization to the print advertising or is this a supplemental buy, do you find?

Christian A. Hendricks

I would say that the majority of it is supplemental buy, that there’s not switch business. There are a lot of new advertisers in this category and advertisers who just want to buy it.

I also forgot to mention that in the future in the retail category, we do expect to see gains in the ’08 and ’09 really from the Yahoo! partnership as the ad platform is realized and we begin selling their inventory in the local marketplace.

Thomas Russo - Gardner Russo

Right. Other observations across the categories of the digital advertising in terms of the trends toward CPMs, anything else that is discernible? Increasing, flat, pressure on CPMs -- just a general look across the digital categories for the CPMs.

Christian A. Hendricks

Generally at the local level, the CPMs are rising because it is a supply/demand type of business. As more advertisers want the inventory we have, we can push up rates. At the national level, they pretty much remain consistent. There is plenty of ad inventory out there for just general advertising as opposed to a specific local type of business.

Thomas Russo - Gardner Russo

Thank you, and then lastly, what is the prospects for either print or digital as we approach the second-half of the year with the political election season upon us? Related to that, Chris, will you have any video links dropped in to your digital offerings to try to tempt some more video-minded participants to whom advertising can be placed? What do you look forward to in terms of both what you offer the user and then what you might get paid for for what you offer?

Christian A. Hendricks

I’ll start with the political question. We have talking to lots of the agencies and lots of the campaigns right now trying to figure out how we can work with them more closely to bring political advertising to our website. We hope that will turn into some money. Especially, we have launched recently our D.C. Bureau site and that has become a very popular site. If you haven’t seen it, it’s at McClatchydc.com.

As for video, we are pushing video through our sites. We have AP video on our sites. We have local video on our sites, whether that’s sports or just news oriented, and we also are starting to move forward with user-generated video.

In the category of local video, which is the video that we generate, whether it’s news or sports, we do have pre- and post-roll advertising that is sold on those sites. It’s a very small piece of the business but it is exciting for us. Kansas City has done a stellar job with this. They are posting five to eight local news videos with pre-roll advertising sold on it. Every day they post five to eight of those videos.

So we expect more of the video and we expect that we will see some growth in the political category in the coming months.

Thomas Russo - Gardner Russo

Thank you.

Operator

Your next question comes from the line of Jake Newman with CreditSights.

Jake Newman - CreditSights

Thank you. I would like to ask about balancing shareholder initiatives against debt reduction. The $600 million to $700 million in 18 months seems likes a target of sorts. Once you have reached that, where do you think you are going to be in terms of being able to use free cash flow for things other than debt reduction?

A corollary to that is do you think as part of that target that you would regain an investment grade debt rating? Is that kind of a precursor to being able to do something more on the shareholder initiatives?

Gary B. Pruitt

Thanks for the question. I’ll attempt to answer all of those cohesively here. First of all, we’re pleased that it’s a relevant discussion to talk about use of cash in the sense that McClatchy remains a prodigious cash producer. So I think all parties, all shareholders, management, board, et cetera, agree that we should use cash to further the interests and build value for shareholders.

Our priority is debt reduction currently because the actual number and in terms of debt leverage, we’re at a higher level and an unprecedented level for McClatchy and a little over 4.5 times debt to cash flow. In fact, we’re in the process of obtaining an amendment to our credit agreement to get leverage ratio -- to get a slight amendment to allow leverage ratio to go to 5 times for the next nine months or so, or for the next year to nine months, at no cost to the company but just to have a little more freedom. We don’t expect to have to use it but just to be safe.

And so the company would prefer to reduce debt, to reduce risk, especially in a challenging operating environment. So that remains our top priority. But that being said, it isn’t our only priority and as we look ahead, we will -- we’re not -- we certainly are not ideologically opposed to buying back stock at all. We would like to buy back stock. The question is when, not whether.

We don’t have a specific goal in mind. We did want to highlight the $600 million to $700 million for shareholders so that you could see that there is a significant amount of potential there as we pay down debt and a good story in terms of building equity value by deleveraging.

But we will be looking -- not later, we will be looking next year and beyond at the possibilities of stock repurchases based upon the stock price, operating conditions and interest rates and other factors. And the board had given us authorization for a $200 million stock repurchase before the Knight Ridder deal and then after the Knight Ridder deal, we focused on the debt repayment as it remains our priority now. But it is certainly not to be our exclusive focus long-term and we will be giving updates further to our shareholders on that mix.

And as far as -- we don’t have a goal necessarily of achieving investment grade before we do one thing or another. We can’t really -- I don’t really know what the rating agencies are going to look at in terms of investment grade and in general, investment grade would translate -- the only meaning to me would mean it would translate to lower interest rates under our credit agreement. So it would be a desirable goal in that sense. But we haven’t set it out to be our focus. Rather, we focused on reducing debt and growing cash flow. As a result, the ratio will look better.

So I imagine we will achieve investment grade but I don’t know exactly when.

Did I answer all of your questions?

Jake Newman - CreditSights

Yes, you did. Thank you.

Operator

Your next question is a follow-up from the line of Craig Huber with Lehman Brothers.

Craig Huber - Lehman Brothers

My main follow-up was answered but can you just give us the consumption and average newsprint price change in the quarter, please? Thanks.

Patrick J. Talamantes

Craig, during the quarter pricing was down 6.3% and tons were down 11.1%.

Craig Huber - Lehman Brothers

Thank you.

Gary B. Pruitt

Thank you.

Operator

Your next question is another follow-up with Karl Choi of Merrill Lynch.

Karl Choi - Merrill Lynch

Just a couple of housekeeping items; Gary, you mentioned the pension expense will go up in the second-half. I wonder if you can quantify it. And then, just to clarify, the capital core over at Seattle, the $24 million, is that going to be real cash out the door for you in the third quarter or is it just an expense item?

Gary B. Pruitt

The Seattle Times is not a cash item, so it would be a non-cash item for us. Pat, do you have any report on the pension?

Patrick J. Talamantes

Sure. The pension in the third quarter will be up about a couple of million dollars and the reason for it has to do with purchase accounting, not the normal assumptions that we typically deal with. We got a benefit a year ago from purchase accounting in terms of how the actuaries had us lay on the expense in the second-half. We’ll see that couple million dollar benefit in both the third and fourth quarters.

Gary B. Pruitt

No, we’ll see an increase.

Patrick J. Talamantes

I’m sorry, excuse me, the increase in both the third and fourth quarters. We got a benefit a year ago.

Karl Choi - Merrill Lynch

Thank you.

Operator

It appears that there are no further questions. Do you have any closing remarks?

Gary B. Pruitt

No closing remarks. I just want to thank you for your attention and support -- look forward to better results ahead. Thank you very much. Goodbye.

Operator

This concludes today’s McClatchy second quarter 2007 earnings conference call. You may now disconnect.

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Source: The McClatchy Company Q2 2007 Earnings Call Transcript
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